Precious Points: Old Number 7
"The weekly chart in the yellow metal shows a little more room to run as price rockets upward from the 5-week moving average. Though silver closed above the 50-day sma, the vibration around this level suggests it could be retested early next week, with $12.60-12.65 probably providing good support. A positive test would clear the path for $13.00, which should prove formidable." ~ Precious Points: Sustainable Growth?, September 9, 2007
For a brief period on Friday, gold traded back to its old May 2006 high near $725 and, with the Fed likely to offer at least some modest accommodation on Tuesday, gold could see another attempt at a new high. Last week's update, however, questioned the sustainability of this move given the uncertainty of domestic and foreign markets and the Fed's ability or willingness to mitigate the housing recession. Though the long term outlook for metals is as optimistic as ever, the possibility of a rebound in the dollar, a significant slowdown in the global economy and/or a resurgence of the credit panic could trigger an eye-raising selloff in the coming weeks or months.
While it's true that seasonality will begin working in favor of the metals as the days grow shorter and cooler, there's no lack of reasons to be cautious at these lofty levels. As mentioned over and over in this update for nearly a year, recent history in gold has been to make lasting strides not in times of crisis, but in times of recovery once the worst is past and policy accommodations have had time to move from base money to the circulating money supply. By the Fed's own admission we have not yet seen the worst in mortgage defaults and, though LIBOR, Treasury and corporate paper rates all improved incrementally last week, there are few if any willing to sound the "all clear" at this point - at least not before hearing from the Fed and the brokers.
And, if indeed there is a policy accommodation forthcoming from the Fed, as appears probable, it's still likely to be little more than the 25 basis points already priced into stocks and commodities. The reasons for this assessment are varied and manifold, but at or near the top of the list is inflation which, though expected to be contained in terms of PPI and CPI, is notably troublesome in terms of $700 gold and $80 oil. Consider where these two commodities were priced five years ago and that, for most of American history, the price of gold at least was fairly stable. Given the undeniable inflation risk (or inevitable), the economic outlook has not yet deteriorated to the extent the Fed will be taking drastic, emergency action, even despite the duel threat of the housing recession and credit market turmoil. In fact, that credit conditions have recently improved, though modestly, consistent with the interpretation of Bernanke's "timeliest indicators" propounded by this update but overlooked by the mainstream media, could even have the Fed holding the target rate steady.
Obviously, leaving the overnight target unchanged would be disastrous for stocks and metals, but the wild card in the deck is the discount rate. After watching the Fed keep inflation as its predominant policy concern in August only to take evasive action two days later, there remains the outside possibility the Fed will not yet tinker with its rate targeting machine (5.25% is still accommodative, historically speaking), but rather lower the discount rate to at or below the target rate and deal with emergencies as they arise. This would also stave off the impression the Fed can be coerced by the market's expectations, prevent a moral hazard, and continue the Fed's preference for banking institutions over unregulated lenders and non-depositories. To the extent that this is not the market's expectation, the reaction is difficult to predict, but anything that leans towards an increase in liquidity is eventually bullish for the metals.
The third major danger to the metals rally is that the global economy is not as strong as currently perceived. The bank run in England on Friday, video of which was aired on networks which chose to utterly avoid mention of a similar occurrence at Countrywide Financial branches a few weeks ago, is another sign that the subprime contagion is not limited to American soil. Not only is there subprime risk in England and Spain based on real estate speculation in those locales, major banks in England and Germany at least have already indicated profound exposure to collateralized debt originated in America. The bottom line is that if the brokers announce less than disastrous earnings and guidance next week, the real takeaway could be that the holders of most of the toxic derivatives are actually outside the United States. There's also the Chinese stock market to consider which, like Western markets, is probably a discounter of future earnings. By most accounts, the 2008 Olympics will mark a near term peak in Chinese infrastructure development, and at some point soon this could start to be reflected in Shanghai markets. Any or all of these outcomes would trigger a resurgence of the US dollar, if not US stocks, which shouldn't necessarily be disastrous for gold, but would undoubtedly be negative given the tendencies of most traders.
The weekly chart in gold shows a notable reversal from the week's highs, consistent with the chart shown here last week, but a fairly insignificant week over week decline. As mentioned previously, a new attempt at $725 is entirely likely given the expectations for next week, but losing the psychologically important 7-handle is also a realistic possibility. Notice that a decline to the 50-week moving average from here would look catastrophic, but would still only take gold to about $655 and totally retain the long term bullish bias. A move of the 5-week moving average above $700 for the first time in this entire bull market would be a more convincing indication of the sustainability of the current move.
As expected, the 50-day simple moving average was an important level in silver last week. And, after losing that level on Thursday but regaining it on the close, silver made a run for $13 and was repulsed by the strong resistance there. Having closed on the 50-day moving average, the next move in silver could be in either direction, but there's not likely to be any significant moves before the Fed statement and the Lehman earnings, suggesting a range between $12.65 and $12.75 until the next major move. Still, recent action has been encouraging.
So, while this is far from a call to sell gold and silver, it is a call for caution. Physical holdings are always safe to hold for the long term, but buying now should be short term and is speculative at best. If this is indeed the start of the next major leg up, there will still be time to accumulate later. The chart below is Dom's updated Elliott wave analysis for gold. If you're not a member, and therefore not privy to the count or the rest of the pattern, consider that since May '06 gold has traded in a seemingly corrective move and is approaching new highs off the initial selloff.
In the meantime, I will personally be spending next week in the Tennessee hills and will likely visit the Jack Daniel distillery in Lynchburg to enjoy some old number seven along with the yellow metal (not in the dry county of course). And, while gold could be poised to lose it, here's hoping I don't! See you next weekend!